Gold has enjoyed
an amazing rally in recent weeks, catapulted higher by the extreme
fear sparked by the sharp stock-market correction. Naturally such
big and fast gains have led to a surge in gold’s popularity among
investors and speculators, as everyone loves a winner. But gold
prices flow and ebb like everything else, and this metal has
become very overbought today.

Many gold
enthusiasts’ hackles will bristle at the mere idea of gold being
overbought. They will counter with many fundamental reasons
why gold is heading higher, or argue that current newsflow will
spark escalating buying. But gold’s long-standing
bullish
fundamentals do not override short-term technicals. When any
price rallies too far too fast, including gold’s, the odds balloon
for an imminent retreat.

As a hardcore
contrarian, I started recommending physical gold coins to our
subscribers as long-term investments way back in May 2001 when gold
was universally loathed. It traded under $265 per ounce then! Over
the long decade since, though gold has indeed powered higher on
balance in a mighty secular bull, it has still weathered many
corrections and consolidations after getting too overbought.

And at the eves of
every one of these necessary selloffs to rebalance away excess
greed, the majority of traders were wildly bullish. After
any big and fast move, in any market, near-term enthusiasm waxes
extreme. Traders’ collective bravery peaks near major highs, where
they should be afraid of healthy selloffs. And if you follow the
financial media, you know the love for gold today is pretty
overwhelming.

Though sentiment
is ethereal, impossible to directly measure, the price action that
drives it is concrete. I suspect any technical tool you want to use
will reveal gold to be very overbought today. Consider seasonals
for example. Gold tends to drift sideways in the summer due to a
lack of major income-cycle and cultural drivers of outsized
investment demand. Obviously this hasn’t been the case this year!

This first chart
is updated from my
PM Summer Doldrums 3 essay of early June. It takes each
summer’s gold action in this secular bull and indexes it
individually to the last trading day in May. This enables us to
compare every gold summer in perfectly-comparable percentage terms.
The yellow lines are each summer from 2001 to 2010, the red line is
the average gold performance of all these past summers, and the blue
line represents 2011’s indexed gold action.

Summer 2011
initially began like most other summers, with gold meandering
sideways to lower. But after bottoming in early July, gold started
to rally. You remember the primary catalyst, the debt-ceiling
debate in the US Congress was heating up. Though it was still a
month until the Treasury’s August 2nd deadline for avoiding the
first-ever US default, the fiery rhetoric started ramping anxiety.

The core fight
over excessive government spending was simple. If you compare the
average of Obama’s first 3 budgets with George Bush’s last 3, Obama
grew federal spending by a gargantuan 28%! And this is saying a lot
since Bush was a big spender too, making him very unpopular among
fiscal conservatives. Obama orchestrated this massive
federal-government growth during recessionary years where tax
revenues were 11% lower on average. The result? A quintupling
of Washington’s deficit to an insane $1.25t per year, and a
43% increase in the US national debt in less than 3 years of Obama!

Republicans wanted
to rein government spending back in line with half-century averages
in proportion to US GDP, while Democrats wanted to lock in Obama’s
unprecedented government growth as the new normal going forward. As
the Treasury’s early-August deadline loomed nearer and anxiety
mushroomed, capital gradually migrated into gold. This drove rare
sustained outsized investment demand in the summer months.

By the end of
July, gold was 6.0% above its pre-summer May close. While this was
a bit over the center-mass downtrend’s resistance as you can see
above, it was still fairly normal for a gold summer. But all this
changed on August 2nd when the stock markets sold off sharply
despite a debt-ceiling deal being approved at the last minute. The
S&P 500 plunged 2.6% and gold blasted 2.3% higher on safe-haven
demand.

After that, it was
off to the races over the past couple weeks. Gold rallied the most
on days the stock markets were the weakest. And with plenty of
huge down days in the stock markets, flight-capital demand for
gold drove a series of outsized up days for this metal. The result
is readily evident above, an anomalous, massive, and sharp summer
rally. This drove gold to unprecedented summer-rally heights
in August, much higher than anything yet seen in this entire secular
bull.

By the middle of
last week, gold had soared 20.4% higher in just over 5 weeks! It
was up 16.7% on the summer, 36.5% since its 2011 lows in late
January, and 26.2% year-to-date. These are super-fast moves for
this giant asset. Are such huge gains over such a short period of
time sustainable? They sure haven’t been in gold’s secular bull to
date! This next chart shows gold’s 10-trading-day, 20-trading-day,
and 30-trading-day returns throughout its entire decade-long bull.

By the middle of
last week, gold’s 10d, 20d, and 30d gains ran way up at 10.9%,
13.2%, and 19.3%. This is hard to interpret without context, but
this chart reveals just how rare such fast gains are. If you
visually extend the latest yellow, orange, and red peaks back over
the past decade, you can see that today’s levels are extremely rare
and short-lived. Gold has never been able to sustain gains
at such a blistering pace.

While gold’s
latest big gains aren’t its best of this bull, after every
prior big-gains spike gold soon fell sharply. Though these
selloffs didn’t always last long, and weren’t always of
correction-magnitude, they still happened like clockwork. Gold
simply can’t sustain massive gains on the order of 10% over 2 weeks,
15% over 4 weeks, and 20% over 6 weeks. These are levels where gold
is too overbought to continue rallying.

Overbought simply
means a price has rallied too far too fast. It has nothing
at all to do with absolute levels. Gold at $1800 might be perfectly
reasonable given its global fundamentals, and its price will
probably be considerably higher by the end of this year. But
over the short term, in the coming weeks or couple months, gold will
likely face some serious selling pressure after such a super-fast
advance. These post-spike selloffs are purely psychological and are
totally unrelated to fundamentals.

When any price
rallies too far too fast, traders get too excited and greedy. These
big gains lead everyone interested in buying that asset to chase the
rally. But soon everyone interested in buying in anytime soon has
already deployed their capital. With all the near-term buyers in,
buying pressure is exhausted and greed burns itself out. At that
point prices top and any selling at all overwhelms the dearth of
buyers. The result is a fast plunge that crushes greed, sparks
fear, and rebalances sentiment. This is very healthy.

Why couldn’t gold
surge even higher first before correcting? Why not up 30% in 30
trading days? Just because it hasn’t happened yet in this bull
doesn’t mean it can’t happen, right? Gold could indeed become even
more overbought, there’s no doubt. But odds are it won’t. One of
the key reasons the big short-term gains in this chart are never
sustainable is the sheer colossal size of the global gold market.

According to the
World Gold Council, about 170,000 metric tons of gold have been
mined in all of world history. Though a little has been lost
(unrecoverable shipwrecks, electronics, dental work), the vast
majority is still around. Do the math and this works out to a
staggering $9.8t worth of gold at $1800 per ounce! For comparison,
at the end of last month the US MZM money supply was $10.1t, and all
500 elite companies of the flagship S&P 500 stock index had a
collective market capitalization of $12.2t.

Gold is an
unbelievably-big market these days, vast. And the bigger the market
capitalization of any stock or asset, the slower it is to move.
Just as a speedboat is far easier to turn than an oil supertanker, a
small stock is far more volatile than a large one. And pushing $10t
today (or even $7.2t back at its late-January lows), the collective
value of the world’s aboveground gold supply is massive beyond
belief. It is 25x larger than the biggest individual stock on the
planet!

Such a gargantuan
asset isn’t likely to move very fast, so outsized moves to the
upside or downside relative to gold’s bull-market history never last
for long. In fact, as you can see above gold tends to bounce back
sharply to overshoot the other way soon after any notable
extreme. After excessive short-term gains gold tends to collapse to
excessive short-term losses, and vice versa. This is why traders
need to be wary of extremely-overbought conditions like we’re seeing
in gold today.

Gold’s major upleg
surges that culminate in sharp vertical rallies have always been
followed by sharp selloffs. These can be corrections, but are
usually just consolidations (sideways grinds). Today’s gold surge
is the fourth major one of this secular bull, as you can see
above. The other three climaxed in extreme short-term gains that
soon collapsed into huge outsized losses as sentiment was
rebalanced.

Another way to
measure gold overboughtness is with my very successful
Relativity
Trading system. It simply renders gold as a multiple of
its own 200-day moving average. This is valuable for a couple
reasons. First, it measures gold’s uplegs in perfectly-comparable
percentage terms over time despite ever-higher gold prices as this
bull marches on. Second, this multiple tends to form a horizontal
trading range over time. This chart shows Relative Gold (rGold) in
light red (left axis) since the stock panic.

Over the past 5
years, rGold has tended to top around 1.25x. In other words, once
gold rallies so far so fast that it stretches 25%+ above its 200dma,
it is unsustainably overbought and an imminent correction is due.
This last happened back in early-December 2009, when gold had “only”
surged 15.1% in 30 trading days to hit 1.248x relative. What
happened right after this surge to very-overbought levels? Gold
immediately corrected, falling 12.6% over the subsequent 9 weeks
into early-February 2010.

Back then I wrote
an essay
about gold being overbought the very week it topped. And as
expected with any outlook contrary to popular consensus, that thesis
ignited a firestorm of criticism and even ridicule. People accused
me of being stupid, ignoring fundamentals, not paying attention to
news, of being anti-gold, and worse. Though contrarian traders
fighting the crowd earn massive profits, contrary opinions near
extremes are never popular. But overbought prices soon correct,
whether we like it or not.

It’s provocative
that gold hasn’t even approached those December 2009 extremes in
relative terms again until this past week! On Wednesday
August 10th, gold surged 3.1% higher on a nasty 4.4% S&P 500 (SPX)
down day, hitting a new all-time nominal high. But it was stretched
to 1.231x relative, very overbought by its own bull-to-date
standards. Then again on Thursday the 18th as I am writing this
essay, another big SPX down day drove another big gold up day to
even higher relative levels.

Can gold sustain
being stretched 25%+ above its 200dma? Is enough new capital going
to flood in right now to drive a $10t asset higher to even
more-overbought extremes? Maybe, anything is possible in the
markets. But based on gold’s bull-to-date precedent for summer
behavior, absolute short-term gains, and stretching above its
200dma, the odds for this rally persisting are very low. And
prudent successful traders never bet on low-probability-for-success
outcomes.

Usually after
seeing similar extremes to today’s, gold corrects back down to
its 200dma. In the context of a secular bull, such 200dma
approaches are common after major uplegs. They are no big deal
technically from a long-term perspective, and are actually very
healthy as they rebalance sentiment to extend a bull’s
longevity. But in real-time, they feel incredibly brutal. Today
gold’s 200dma is way down near $1465, 18.1% and $325 lower from its
recent highs! Can you weather such a selloff unscathed?

And even if gold
doesn’t make a 200dma approach after being so overbought this time,
any conceivable correction level you want to mark on this chart is
way lower from here. Merely to get back down to the upper
resistance of its strong post-panic uptrend, gold would have to fall
to $1600 or so. This is 10.6% and $190 lower than its recent
highs! Very-overbought markets have lots of room to correct hard
and fast, they slaughter those who trifle with these serious risks.

What could drive
such a sharp gold selloff? The most-likely catalyst is a major
stock-market rally. It sounds crazy I know, but after such extreme
fear a huge stock-market rally is highly probable as I explained in
my essay
last week. Gold’s summer rally didn’t start surging and getting
excessive until early August as the stock markets started plunging.
This metal’s big up days in recent weeks corresponded exactly
with big SPX down days.

Capital fleeing
the stock selloff understandably flooded into gold, and inflows into
the flagship GLD gold ETF empirically verified this. But as the
stock markets inevitably bounce out of those extremely oversold and
hyper-irrational lows, some of the capital that has been hiding out
in gold will surely exit. Just as the gold buying pressure fed on
itself in recent weeks, so will any selling pressure. As gold
accelerates lower, more and more traders will get scared and start
exiting their recent positions they bought near highs.

In the first 8
trading days of August alone, gold soared an unbelievable 10.1%!
This created a trillion dollars of wealth! The SPX lost
13.3% over this exact span, driving the atypical summer surge of
capital into gold. But after such anomalously-extreme selloffs,
stock markets tend to bounce fast. If the SPX gains 10% in
the coming weeks, again highly likely, will gold fall 5% or 10%?
Probably. And the faster it drops, the more the selling will feed
on itself and drive a sharp correction.

It is really
pretty ironic to see gold overbought this time of year, as
gold seasonals
tend to bottom in the first half of August. Usually right now is
one of the best buying opportunities of the year for this
precious metal, as it is usually unloved and oversold after a
demoralizing grind in its summer doldrums. So it does seem strange
to see gold technicals predicting an imminent correction just as the
strong autumn seasonals are due to begin.

But it is crucial
to remember that seasonals are only secondary drivers at
best. Sentiment, popular greed and fear, is always the primary
short-term driver of any price while fundamentals are the primary
long-term driver. Extreme greed necessitating a correction easily
overrides any seasonality. But once this correction happens and
sentiment is rebalanced, bullish seasonality can reassert itself.
And though a gold correction off of today’s extremes is likely to be
big and sharp, it ought to be relatively short-lived (weeks to a
couple months at worst).

Being a contrarian
is very challenging, it is hard fighting the crowd. It is
stressful and wearying to buy stocks aggressively over the past few
weeks while everyone else thinks the markets are heading into a new
panic. It is no fun to see gold overbought and expect a selloff
right on the verge of the big autumn buying season. I am going to
get a blizzard of hate mail for this essay, mocking me to no end.
Yet buying when others are afraid and selling when others are brave
is the surest way to make a fortune in stocks.

We’ve been doing
this publicly for over a decade at Zeal, with spectacular results.
All 591 stock
trades recommended in our newsletters since 2001 have averaged
annualized realized gains of +51%! This includes all our losing
trades, includes weathering the brutal 2008 stock panic, and was
achieved in a massive decade-long sideways-grinding secular stock
bear. If you want to rapidly multiply your wealth in the stock
markets, you have to steel yourself to be a contrarian and fight
the crowd.

If you’re tired of
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selling low at the first sign of real fear, and perpetually losing
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The bottom line is
gold is very overbought today based on its own bull-to-date
precedent. The combination of the debt-ceiling anxiety and an
overdue and sharp stock-market correction drove rare outsized gold
demand in the summer doldrums. But so much capital flowed into gold
that it rallied too far too fast to be sustainable over the near
term. A healthy correction is necessary to rebalance sentiment.

If the stock
markets stoke more fear, gold may edge a little higher first. But
sooner or later the wildly-oversold stock markets will bounce and
some of the flight capital hiding in gold will exit. This selling
will rapidly feed on itself, likely driving a sharp yet short-lived
correction. If this comes to pass, investors and speculators alike
should prepare for an excellent buying op early in gold’s strong
autumn rallying season.